The Effects of Mandatory Audit Firm Rotation and Mandatory Audit Firm Retention on Opinion Shopping
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Abstract
This paper examines the impact of mandatory audit firm rotation and mandatory audit firm retention on opinion shopping. Both regulations place statutory restrictions on a client’s authority to switch auditors with the aim to curb opinion shopping. However, one strand of the literature has argued that one of these regulations, namely mandatory audit firm rotation, could worsen opinion shopping by disguising client’s intent. This study predicts that these regulations may bring seven major changes to the dynamics of the audit market: (1) financial incentives, (2) detection risks, (3) litigation risks, (4) reputation effects, (5) auditor competency, (6) market competition, and (7) switching costs. These changes, in turn, may affect auditors’ incentives to compromise and clients’ willingness to engage in opinion shopping. Using hand-collected data based on the unique Korean setting where both mandatory audit firm rotation and mandatory audit firm retention have been implemented for all the listed companies, and where each regulation was adopted in a staggered manner, this paper finds that the level of opinion shopping for affected Korean firms during the mandatory audit firm retention period has decreased. Furthermore, this study finds that opinion shopping has increased once the Korean government started implementing mandatory audit firm rotation in the presence of mandatory audit firm retention. This study adds to the literature by examining whether regulations have a significant impact on opinion shopping and by highlighting the unintended consequences of regulatory attempts.